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Death of a theory

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  • James Bullard

Abstract

The author discusses the effectiveness of fiscal approaches to stabilization policy. The conventional wisdom before 2007 was that fiscal policy intervention as a stabilization tool had little to recommend it, mostly due to political constraints and to the unlikely effectiveness of many types of temporary fiscal policy actions. However, with short-term nominal interest rates near zero, attention turned again toward fiscal stabilization policy. The author describes and critiques two theories of how fiscal policy might be viewed as effective in such circumstances. One, heavily studied, is that a tax-financed increase in government expenditures would temporarily increase total output in the economy. The other, lightly studied but rhetorically forceful, is that increased government expenditures may inspire confidence. Both theories have drawbacks, but the author argues the first is dying because of three considerations: (i) actual political systems are ill-suited to implement the advice from the theory; (ii) monetary stabilization policy has been quite effective, making fiscal experiments redundant; and (iii) governments pushed distortion­ary taxes into the future, which in the theory reduces or eliminates the desired effects.

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Bibliographic Info

Article provided by Federal Reserve Bank of St. Louis in its journal Review.

Volume (Year): (2012)
Issue (Month): Mar ()
Pages: 83-102

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Handle: RePEc:fip:fedlrv:y:2012:i:mar:p:83-102:n:v.94no.2

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Keywords: Fiscal policy ; Monetary policy;

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References

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  1. Eric M. Leeper & Nora Traum & Todd B. Walker, 2011. "Clearing Up the Fiscal Multiplier Morass," NBER Working Papers 17444, National Bureau of Economic Research, Inc.
  2. Gabriel Cuadra & Horacio Sapriza, 2007. "Fiscal Policy and Default Risk in Emerging Markets," Working Papers 2007-03, Banco de México.
  3. Kehoe, Timothy J & Levine, David K, 1993. "Debt-Constrained Asset Markets," Review of Economic Studies, Wiley Blackwell, vol. 60(4), pages 865-88, October.
  4. Joseph Gagnon & Matthew Raskin & Julie Remache & Brian Sack, 2010. "Large-scale asset purchases by the Federal Reserve: did they work?," Staff Reports 441, Federal Reserve Bank of New York.
  5. Lawrence J. Christiano & Martin Eichenbaum & Sergio Rebelo, 2010. "When is the government spending multiplier large?," CQER Working Paper 2010-01, Federal Reserve Bank of Atlanta.
  6. Joyce, Michael & Lasaosa, Ana & Stevens , Ibrahim & Tong, Matthew, 2010. "The financial market impact of quantitative easing," Bank of England working papers 393, Bank of England.
  7. Costas Azariadis & Luisa Lambertini, 2003. "Endogenous Debt Constraints in Lifecycle Economies," Review of Economic Studies, Wiley Blackwell, vol. 70(3), pages 461-487, 07.
  8. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "This Time Is Different: Eight Centuries of Financial Folly," Economics Books, Princeton University Press, edition 1, volume 1, number 8973.
  9. Alessia Campolmi & Ester Faia & Roland Winkler, 2011. "Fiscal Calculus in a New Keynesian Model with Labor Market Frictions," MNB Working Papers 2011/5, Magyar Nemzeti Bank (the central bank of Hungary).
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